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BIS Working Papers :The FinTech Opportunity

This paper assesses the potential impact of FinTech on the finance industry. I document first that financial services remain surprisingly expensive, which explains the emergence of new entrants. I then argue that the current regulatory approach is subject to significant political economy and coordination costs, and therefore unlikely to deliver much structural change. FinTech can improve both financial stability and access to services, but this requires significant changes in the focus of regulations.

This paper studies the FinTech movement in the context of the long run evolution of the finance industry and its regulations. The 2007/2009 financial crisis has triggered new regulatory initiatives and has accelerated existing ones. I argue that the current framework has been useful but that it has run its course and is unlikely to deliver significant welfare gains in the future. As a consequence, it is worthwhile to consider a new approach, for which I propose some guiding principles. FinTech covers digital innovations and technology-enabled business model innovations in the financial sector. Such innovations can disrupt existing industry structures and blur industry boundaries, facilitate strategic disintermediation, revolutionize how existing firms create and deliver products and services, provide new gateways for entrepreneurship, democratize access to financial services, but also create significant privacy, regulatory and lawenforcement challenges. Examples of innovations that are central to FinTech today include cryptocurrencies and the blockchain, new digital advisory and trading systems, artificial intelligence and machine learning, peer-to-peer lending, equity crowdfunding and mobile payment systems. The starting point of my analysis, developed in Section 1, is that the current financial system is rather inefficient. To show this, I update the work of Philippon (2015) with post-crisis U.S. data. I find that the unit cost of financial intermediation has declined only marginally since the crisis. The evidence outside the U.S. is remarkably similar, as shown in Bazot (2013). Recent research also suggests that many advanced economies have reached a point where “more finance” is not helpful.1 Significant welfare gains from improvement in financial services are technologically feasible but unlikely to happen without entry of new firms. Section 2 then reviews recent regulatory efforts and challenges. The financial regulations enacted after 2009 are not as far reaching as the ones implemented after the Great Depression, but the evidence suggests that these efforts have made the financial sector safer.2 A defining feature of the current approach, however, is that it focuses almost exclusively on incumbents. This approach is unlikely to deliver much further improvement because of ubiquitous ratchet effects in leverage, size and interconnectedness, preferential tax treatments, and oligopoly rents. These distortions are embedded in the current financial system to such an extent that the political and coordination costs of removing them have become prohibitive. These first two points suggest that it is useful to consider an alternative approach to financial regulation, based on the idea that encouraging entry and shaping the development of new systems might be the best way to solve the remaining challenges in financial regulation. With respect to incumbents, this alternative approach would be a form of containment: its goal would be to consolidate existing efforts and prevent future regulatory arbitrage, but not to impose top-down structural changes. The new approach would focus on entrants and take advantage of the ongoing development of FinTech firms. The main idea is to achieve bottom-up structural change by encouraging, for instance, firms that provide transaction services without leverage, and trading systems that are cheap, transparent and open-access. I conclude by sketching out some guiding principles for this new approach. 1 Inefficiency of the Existing System The main finding in Philippon (2015) is that the unit cost of financial intermediation in the U.S. has remained around 2% for the past 130 years. Bazot (2013) finds similar unit costs in other major countries (Germany, U.K., France). Improvements in information technologies have not been passed through to the end users of financial services. This section offers an update of this work, with two goals in mind. First, measurement is difficult, and statistical agencies have recently made some significant data revisions to financial accounts. One needs to know if these revisions affect the main insights of the original paper. The second reason for updating the series is that the data in Philippon (2015) predates the financial crisis and one would like to know how the unit cost of intermediation has evolved since then. I then discuss recent trend in labor compensation and employment. Finally, I discuss the evidence on the link between finance and growth.

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